Measuring Misreporting Risk in Firms’ 10-K Disclosures and the Auditor’s Role in Mitigating Misstatements

62 Pages Posted: 19 Jul 2017 Last revised: 21 Sep 2018

See all articles by James Moon

James Moon

Georgia Institute of Technology - Scheller College of Business

Quinn Thomas Swanquist

University of Alabama - Culverhouse School of Accountancy

Date Written: September 2018

Abstract

The purpose of public company audits is to increase the integrity of firms’ financial statements. However, research provides mixed evidence on whether better auditors mitigate misstatement risk embedded in the financial reporting process. A challenge in previous studies is the lack of a powerful measure of inherent, “pre-audit” reporting risk. We overcome this issue by developing a novel, powerful measure of accounting misstatement risk (AMR) from 10-K text. We validate this measure by documenting economically significant associations with both audit fees and misstatements. We then empirically test whether relatively higher quality audits, measured using a variety of characteristics, attenuate the association between AMR and subsequent restatements. Contrary to our prediction, however, we find minimal evidence that better auditors mitigate the association between AMR and the likelihood of subsequent restatement. Further analysis supports the notion that AMR inhibits auditors’ ability to mitigate reporting risk through increased audit fees and that AMR captures innate reporting risk rather than managerial obfuscation. Overall, we expect our results to be of interest to managers, accountants, and regulators, all of whom seek to minimize negative consequences of misreporting.

Keywords: accounting, auditing, textual analysis, misreporting risk, restatements

JEL Classification: M41, M42, G32

Suggested Citation

Moon, James and Swanquist, Quinn Thomas, Measuring Misreporting Risk in Firms’ 10-K Disclosures and the Auditor’s Role in Mitigating Misstatements (September 2018). Available at SSRN: https://ssrn.com/abstract=2997967 or http://dx.doi.org/10.2139/ssrn.2997967

James Moon (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Quinn Thomas Swanquist

University of Alabama - Culverhouse School of Accountancy ( email )

Tuscaloosa, AL 35487
United States

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